Friday, 31 July 2009

Where there is no employment advisor

The BBC has run features on Sierra Leone here in the UK in the last couple of days. Here is one of them. A radio report last night talked of the high rates of youth unemployment.

In a modern economy with reasonably efficient markets, school leavers enter into the workforce and can find work eventually by adjusting their wage demands. In a low income developing country, the jobs may not be available at any wage rate, if they are not created by the school leavers themselves. They often do; African cities are full of young entrepreneurs trying to survive any way they can. A problem arises if the demand for their services and products is not sufficient to provide them with enough to live on, which can happen if the market is not well developed.

Development assistance should aim to move the market to a state where it is well enough developed to allow everyone to earn a living wage. The aim is achieved by setting the economy on its way to economic growth, which involves continuous improvement in one of growth's determinants. The determinants include domestic capital accumulation, educational achievement, market networks, and infrastructure quality. The developmental quality of temporary aid should be judged on whether it starts sustained accumulation of domestic improvements in one or more of the determinants. The quality is not independent of conventional humanitarian aid quality - people are probably not accumulating if they are starving or fighting - but does not necessarily perfectly coincide with it.

The micro-macroeconomic model with borrowing

Here is an extension to the small macroeconomic model described on Wednesday. It includes borrowing. Company profits are given by

P = I - C - R

and company income is given by

I = a*C + b*R.

a and b are constants that may be greater than, equal to, or less than one, depending on how the market and economic growth are interacting.

R is borrowing repaid by the company, and may increase the rate of output. If R falls, then rising inefficiency may be modelled as falls in a and b, decreasing profits. A high interest rate may be modelled as a fall in b, again lowering profits. A government may have a role to play here by increasing the availability of money through spending or printing money if the interest rate is stubbornly high for some reason outside of conventional supply and demand explanations.

Wednesday, 29 July 2009

A compact representation of macroeconomic models

Here's a compact way of representing some of the major variants of modern macroeconomic models.

Companies earn a profit equal to P = I - C where I is income and C is wage costs. Employees receive wages equal to C and spend an amount which generates company income of a*C for some number a. So I = a*C.

A classical analysis may view C as changeable without I changing much. So if a < 1, companies can be made profitable again by cutting wages.

A Keynesian analysis may consider I to be tied more tightly to C because of wage earners' spending preferences. So I falls if C falls, and if a < 1 companies will not be able to make a profit no matter how much they cut wages.

Modifications can be made to the two models, some of which bring them closer to each other. If in the classical model wages are linked to income because of labour market power, then we have the same outcome as for the Keynesian model. In the Keynesian model, if workers do not act on a wage fall - perhaps prices have gone up and they have not asked for a wage rise - the model should move closer to the classical one.

UN refugee data

The UN data service is reporting data on refugees here. I am not sure whether it is a new arrival to the database. The data is of interest in itself, and also as an indirect measure of quantities like political repression in a source or recipient country.

Saturday, 25 July 2009

Estimating output equations using value data

Output equations are commonly used in macroeconomics. They have a leading role in explaining why some countries are rich or have large economies. The equations generally look like Y = f(K,L), meaning output depends on capital and labour. They are usually measured using financial values for output and capital.

The research paper here rejects a common interpretation of the equations when financial values are used in estimation. The argument, in my words, goes like this.

"It might be the case that output measured in physical goods is dependent on machines and physical goods used in production, as well as on labour. But the market value of the output, physical good inputs, and labour could be anything. For example, labour might have a great deal of market power and so be able to charge much more for their services than machine owners could. So the relation between output in physical goods and inputs in physical goods is not well measured by the estimation using values.

"What we do know is that total output is paid to capital and labour. This is an accounting equation, with little economic content. It accounts for the success of equations estimating the output equations; what they are measuring is the accounting identity in an approximate form. The estimated dependence of output on capital tells you little about how physical output varies with physical inputs, and a lot about how much those inputs are paid."

I have not worked out mathematically how people buying the goods would adjust their purchases of inputs faced with different market power of capital and labour suppliers. A non-precise argument is that they would tend to reduce the purchases of the expensive inputs, so the input prices would vary, and so as a result would their market values. Consequently, the equation estimation would be closer to the estimation of the effects on output of physical quantities. However, market values might not adjust perfectly to offset the change in prices - for example, a monopolist supplier of capital would likely see their income drop sharply if they sold part of their capital and broke up their monopoly. This loose argument suggests that the estimation of output equations gives the accounting identity but also partially the production equation.

Growth macroeconomists' research papers often include the assumption of perfect competition, which affects the relation between the physical and accounting equations. The implications of the above arguments are not generally used in analysis after estimations, although it would be a natural insertion into the "robustness section" that often occurs in empirical papers.

If you are interested in the previous arguments, one of the authors has a full directory of their research here, including alternative empirical estimates of the East Asian growth experience, which is helpful as criticism without a different empirical approach can be deflating.

Friday, 24 July 2009

What is hedonic price analysis?

Hedonic price analysis examines goods in terms of their components or characteristics. When shopping, people might consider a food's appearance and nutrition and be willing to pay a certain amount for each. So using hedonic analysis, the total cost of the food would be modelled as

price = appearance * price of appearance + nutrition * price of nutrition

Hedonic pricing helps with assessing how consumers value different aspects of a good. In the example just given, we may be interested in appraising how much people value a food's appearance relative to its nutritional content (some estimates for the valuation of various nutritional elements are given in the research here for United States consumers). If we know about the appearance and nutritional content of a new good that is soon to enter the market, we could estimate its price. The original hedonic equation might have to include a cross-term to make it accurate - consumers might value sweetness and they might value savouryness, but not together. A large negative cross-term sweetness*savouryness would capture their dislike of the combination.

Hedonic pricing also has applications in calculating price inflation and for comparing international prices. We might find that two countries have the same number of computers, but they have different computing speeds. We should make allowance for the different qualities, and hedonic analysis is one way of doing so. Some approaches are described here.

Monday, 20 July 2009

Price elasticities of meat demand in Africa

Economists have used many models of how demand for a type of meat changes with its price and the price of other types of meats. One of the common models is the Almost Ideal Demand System, first proposed in the paper here. If we have four different types of meat, the demand function for the first meat has the form

share in total meat expenditure of meat 1
= a(1)
+ b(1,1) * ln (price of meat 1)
+ b(1,2) * ln (price of meat 2)
+ b(1,3) * ln (price of meat 3)
+ b(1,4) * ln (price of meat 4)
+ c(1) * ln (total expenditure on meat / price index of meats)

Similar equations apply for other meats, and other influences on demand can be introduced into the equations. There are several conditions on how the different equations' coefficients relate to each other. The estimation is often undertaken by the method of seemingly unrelated regression (described here), with one of the equations being dropped to avoid problems that arise because of the conditions reducing the freedom of estimation. There have been other methods built on SUR for handling data of particular forms, such as those which use household surveys.

I estimated the Marshallian elasticities of demand for chicken, beef, pork, and lamb for world countries, dropping the lamb equation. Marshallian elasticities of demand measure how people change their demands for goods if the price of goods change and their income stays the same. My agricultural data covered the years 1991 to 2003 and was from the United Nations Food and Agricultural Organization here. The estimation was on annual data.

The table below shows chicken demand results for the African countries in the data, together with the United Kingdom, the United States, and the world as a whole for comparison. Chickqchickq means the percentage change in chicken demand in response to a change in chicken price, chickqcowp means the percentage change in chicken demand in response to a change in beef price, and similar for the other two elasticities. The elasticities are calculated at the averages of the variables involved.

The own-price elasticities of chicken are generally negative, which is what one may expect; as its price goes up, demand goes down. There are some exceptions, however: Burundi, Gambia, Ghana, and Madagascar. The explanation may be that the data is inaccurate, or the estimation is imprecise for various reasons. However, the estimates may reflect reality in showing a shift in demand. For example, if people stopped rearing chickens over the period (perhaps in Burundi the conflict encouraged people to abandon rearing, or in Ghana quite rapid development led people to work in salaried employment rather than rearing), then there could be a demand shift causing a simultaneous increase in price and demand. In the absence of those variables being included in the estimations, we do not know, but the possibility is interesting. Something similar occurred in the United Kingdom over the same period with a plausible demand shift towards chicken because of health scares associated with beef.

The cross-price elasticities are mixed in sign, and are often negative. As beef prices rise for instance, generally the demand for chicken is found to go down in these elasticities. However, the Marshallian elasticities do not allow for changes in income due to the price changes, and allowing for them (using Hicks elasticities - some of the maths is here) may give positive cross-price elasticities.

Thursday, 16 July 2009

Reasons to mourn the discovery of oil

Sometimes there are celebrations when oil is discovered in a country. Here are some reasons to mourn the discovery, and apply in both well-run and badly-run countries to a greater or lesser extent.

1. It reduces the pressure for formation of capitalist political groupings and democratic institutions.
2. It often leads to autocratic government.
3. It often leads to seccessionist movements in the areas with the oil wealth.
4. It often leads to military movements associated with the seccession.
5. It increases the opportunity for corruption.
6. It increases the pressure for foreign interference in government.
7. It increases the pressure for foreign military involvement.
8. Economic distance can lead to political isolation from major capitalist economies.
9. It reduces the incentive to invest in physical capital.
10. It reduces the incentive to invest in human capital.
11. It reduces the incentive to innovation.
12. It reduces the options to use new techologies.
13. Growth becomes dependent on other people's economies and innovation.
14. The dependence may lower national esteem.
15. It reduces economic diversification.
16. It makes it more difficult for non-oil producers to export.
17. Import earnings are unstable.
18. Government revenues are unstable.
19. The transition after the oil runs out may be difficult.
20. Oil increases global warming.
21. It often leads to inequality and related problems.

The reasons came to me quickly. They seem fairly good reasons. It might be a challenge to see if fifty of them could be reached within twenty minutes.

A private government has no claim on public assets

The Equatorial Guinea government's distribution of income comes in for criticism here, with rapidly rising wealth for its political elites and diminishing living standards for the general population. I find the government's reported ability to take the country's oil wealth notable as the population seems to have no power to get any of it. For me, it raises the question of whether the oil is really available for sale. Unless the politicians own the oil instead of the population, then the politicians are selling something that does not belong to them, exclusively for their own benefit. The buyers are doing the equivalent of handling stolen property. I have a similar concern with a country incurring debt through an unrepresentative leader who disappears all of the money. The lenders lent it to a private individual who took it for private uses. The country has no debt to the lender, and there is a lender liability to the population if the country or population has suffered as a result of the lending. I am not sure if anyone has tried to bring a class action against international lenders in Western courts for pain caused by their negligent actions. It seems not unreasonable to do so, and some lawyers might be willing to take the cases for a fee based on a share of any potential settlement. Some of the liability would be due to foreign governments who advised incorrectly on the legitimacy of the borrower.

No permanent damage from militaries

The news item here describes how African militaries are sharing information on how to avoid HIV transmission among and by their soldiers. The action would help to avoid permanent damage to their host communities. The no-permanent-harm operating principle could avoid heavily criticised activities of armies and militias in Africa: child soldiering, mass rape as a tactic, amputations, wilful destruction of capital, and so on. It doesn't stop looting, rape, and murder that accompany many military campaigns around the world, but does keep the societies more liveable after commanders die or decide that their enemies can be accommodated politically.

Monday, 13 July 2009

The different effects of advanced technology in high and low income countries

A country's output depends on the equipment it uses to produce it, and most equipment works better when it is used by trained personnel, is regularly maintained, and has readily available spare parts. The idea occurs frequently in macroeconomics in the form of technology being specific to a certain set of country characteristics, and has attracted theoretical and empirical support.

Here are some regressions I ran earlier on a model

Output = Constant * capital^a * education^b * technology^c * error

The regressions show the different effects on output of telephones and computers in rich and poor countries. Rich countries might provide much more supportive conditions for operation of these technologies, and so have higher estimates of the coefficient c. So it turned out:

As a moral: advanced technology may become more beneficial to developing countries as they get richer. Early on in development, it may seem that advanced technologies are bringing little benefit.

Sunday, 12 July 2009

How do companies change their capital use when an economy is going through a business cycle?

Economies often go through business cycles, where output expands and then contracts and then expands again. The variations in output during business cycles are quite small, perhaps a few percent, and they only last a few years. Businesses could respond to the downturn by getting rid of their capital or labour, but that would incur sales or redundancy costs, and when the economy turned up again they would probably have to buy or hire again, which would incur new costs. Sales and redundancies do happen, but much of the time it is cheaper for companies to keep their labour and capital the same, and just work them easier or harder when the economy is contracting or expanding, respectively.

Economists using data on capital and labour in estimation face a problem as a result. For example, they often calculate capital manually from investment data or from company purchase costs or in other ways that do not measure how hard the capital is being used. If an economist wants to estimate capital's effect on output, and if we are not allowing for usage intensity, then capital will seem to have a different relation with output that it really does.

Economists would like to know how hard capital is being worked. It is not something that is readily available in statistics. An ad hoc adjustment can be made instead to capture some of the changes in usage intensity, albeit imperfectly. One way is to calculate some simple trend in output, then work out how much higher or lower output is at every time. If output is higher than is trend, then capital is assumed to be working harder than usual, and if output is below trend, then capital is assumed to be working easier than usual and adjustments are made. For example, the paper here (on page 13) uses a simple time trend. It is not a big chore to make the adjustments. For example, the following pseudo-code generates the adjusted capital:

regress gdp on year
predict time_trend=regression_estimates
generate adjusted_capital=capital*(1+(gdp-time_trend)/time_trend)

The adjustment matters. For example, an estimation of output on capital and labour (in log form) gives

ln output = 0.59*ln capital + -0.09*ln education + other terms
(details: world countries, panel data for the 1990s, fixed effect estimation with time dummies)

while an estimation of output with adjusted capital gives more likely coefficients

ln output = 0.46*ln capital + 0.14*ln education + other terms.

Friday, 10 July 2009

Innovation research survey

I came across this research survey here on innovation. It has a broad coverage of the subject, so it is more a classification of research and pointer for further reading, rather than a critical review. Still, I found it helpful.

Uganda and Tanzania's productivity response to international technology

I was going to present some evidence on how these two countries respond to international technology, but the results have lacked coherence. They will be revisited in the future, and presented here. Apologies for the vacant post, but that's how it turned out.

Sunday, 5 July 2009

Applications for MA Economic and Governmental Reform at the University of Westminster

Here's a reminder about applying and getting funded for the Master's course in Economic and Governmental Reform at the University of Westminster here in London, starting in October. I teach the economics modules on the course. African applicants are most welcome and have good performance records.

Our students have come from government, private sector, and NGO backgrounds, and after the course have moved on to senior positions in Africa, Europe, and beyond. Living in London itself offers many attractions and opportunities, of course.

Information on the course and obtaining funding is on its website (here). The course, like most in the UK, is expensive (GBP10,000), so students usually have applied for scholarships first. Course requirements are listed on its website, although there is some flexibility. Unavoidable ones are:

1. Reasonable English (or things won't make sense)
2. A first degree with some relevance to the topic, or a degree and relevant work experience
3. Willingness to work hard (or things will not be enjoyable)

Good luck with application.

Getting the most out of remittances

Many Africans work abroad and send remittances home. I read the World Bank paper here a while back and it appealed for its discussion of remittances' benefits and risks (from page 18). Expatriates may find it helpful in raising the effectiveness of their remittances and other contributions back home.

How do new technologies get into a country?

New technologies may increase output using the same inputs as old technologies. Even if the technology's innovator is powerful in the market, it is probably unusual for them to have such strength that they can take all of the increased output as extra income rather than letting some of it pass to consumers or producers copying the technology. Thus, a developing country may benefit from adopting new technologies from rich countries.

The question is how the technologies get into the developing country. Three routes often examined in the academic literature are imports, exports, and foreign direct investment (for example described in the review here). Strong links with domestic technology have been found with imports from high technology countries, some links with foreign direct investment, and (so I've read, I haven't assessed it myself) few links with exports.

A candidate explanation for the results is that countries' technological improvement is based mainly on importing technological goods from abroad. In this explanation, there may be only a minor role for improved domestic technological expertise in increasing productivity. A alternative sub-explanation allows for increased expertise playing a bigger role, as domestic entrepreneurs study the imported technologies and learn from them. As a possible point against this alternative, several studies using patents have found that innovators tend to base their innovations much more on existing local technologies rather than foreign ones. It may be that local technologies are more suitable building blocks.

The explanation does not give much of a pivot for policymakers wanting to get their population understanding and innovating in new technologies. The explanation is qualified by more detailed evidence from the studies, and also by the broader observation that countries have often moved from lagging behind world leaders to become major innovators, including the United States and Japan. Research on what domestic qualities increase technological adoption indicates that education is important. Education plausibly has more impact on the ability to reverse engineer technologies and copy them than on the ability to use them when they are embedded in imported goods. Although the mechanisms for spread of abstract technological knowledge have not been investigated extensively, the importance of one of the determinants of their success suggests that they collectively are important. Future research may help to clarify how significant are the contributions of reverse engineering, student movement, examining patents and other publications, and personnel movement.

Friday, 3 July 2009

Is there an African economics distinct from conventional economics?

By the question in the title, I mean "are the models and estimates from economics taught in the West suitable for examining Africa's economies?"

When an economic model is presented, it is intended to represent the human behaviour and processes that lead to exchange of goods and money. Many economic models have for a long time assumed individual utility maximisation, that is, people act individually in a way that they choose in preference to other actions. The definition often does not require that people make themselves most happy or most long-lived, but merely that they chose the actions, so the definition is tautological. It is given content by some common assumptions about how utility behaves. For example, if someone is observed to choose to play football for two hours rather than basketball for two hours, then it will often be assumed that they will choose to play football for one hour rather than basketball for one hour. Or, if they choose dancing rather than football and choose football rather than reading, then it is assumed they will choose dancing to reading.

The assumptions can and have been changed in some models. They are flexible, so the method used should be able to describe African economic behaviour. Whether there are adequate models to describe some common situations faced in Africa is a different matter. For example, I will wager, from a position of ignorance, that the number of models describing frequently ruptured, government free, barter economies in the East of the DR Congo is far less than the number of models describing developed country recessions.

That said, even in Africa there are more countries who go through expansion and recession than experience East Congolese conditions. The exceptional circumstances in Africa may be omitted from the Western models, but the models still explain much about African economies. The greater incompleteness of the models may be apparent as a weaker overall fit, or parameters estimated less well. Parameter differences may also emerge if people in Africa make different choices to people elsewhere, on average.

Internal and external sources for epidemic spread

Several countries have had outbreaks of swine flu in recent weeks. Many accounts say that the disease emerged in Mexico, passed to other countries when travellers left, and then started spreading within the new countries.

Mexico can provide a steady source of cases for the new countries, limited by the number of people travelling out of Mexico to them. Once in the country, people can pass the disease on to other people. When there are a small number of people with the disease, the rate of internal spread is small, being no greater than the number of people who they meet, and less than the number of people who have brought the disease from overseas. Over time, the internal rate of transfer picks up and overtakes the external source. The exact overtaking time and the pattern of emergence depend on the effectiveness of transfer, number of foriegn travellers, and other factors.

There is an analogy between flu spread and technology transfer. Early on in a technology's life, it may be acquired from abroad for example through trade links. As time passes, people are exposed to the technology through domestic contact and internal transfer can overtake foreign transfer, dependent on factors like whether the technology can be easily learned.

The graph shows the influences of external and internal sources for technology spread along an S-shaped curve. The external source (the straighter line) is earlier more important, and there would be no spread at all without it. The internal source (the curvier line) becomes more important after a while, and accounts for most of the spread from then.

Free financial software sufficient for most economic analysis and presentation

I mentioned in Tuesday's post a good piece of free mathematical software available online. I think that for most economic analysis and presentations in business and academia, it would be sufficient to work with the following bits of free software:

Open Office available here.
Gretl available here.
Maxima available here.

For presentation and common empirical analysis, Open Office is enough. Gretl allows for more complex empirical or academic analysis. Maxima is helpful if theoretical analysis is required too.